Companies tend to do best today what they did best yesterday…not what they’ll need to do best tomorrow.

In working with companies of various sizes, in various industries, I’ve noticed that the most significant strategic challenges are those brought on by some fundamental type of industry change. Anticipating and adapting to industry change is at the heart of what competitive strategy is.

I’ve also noticed that not all industry changes are of the same magnitude or carry the same degree of strategic implications. I’ve begun informally categorizing these changes with regard to their impact on industry players. We’ll call these—in ascending order of how difficult they are to manage successfully—Levels 1, 2, and 3.

Level 1 industry change – “New kid in town”

In a Level 1 industry change, a major player enters or leaves the industry. This could be a major buyer, a major competitor, or a major supplierfor the industry.

Examples of Level 1 change abound, and you can usually pick up a financial journal at random and find one. I just now did exactly that, and find two pages into my search an article reporting that Warner Music Group is selling its music publishing business (leaving one less player there), in hopes of clearing anti-trust to be able to buy the foundering EMI (leaving one less player there as well). EMI owns, among other assets, the master recordings by my all-time favorites, the Beatles.

Level 1 changes can require significant adjustments in any industry. However, relative to other types of industry change, the impact of a Level 1 change on existing other players is low.

Level 2 industry change – “Technology-driven disruption”

In a Level 2 change, a technology or business model enters that is betterfastersmallercheaper than existing approaches, causing major wavesin the industry’s value network.

Many of the examples that Professor Clay Christensen cites in The Innovator’s Dilemma are of this type. He discusses the hard disk manufacturing industry, where he had been an executive, and where each successive generation of technology provided an order of magnitude greater user value at lesser cost. New companies were able to enter the market based on offering these new technologies, and older players—and this is central to Christensen’s lesson—were often not able to compete as effectively as the new players.

The net result of a Level 2 change is typically that incumbent players (the former winners in the old technologies) cannot adapt quickly enough, and eventually begin to exit the business (whether voluntarily or not.) The new players (with the new technologies) become the new market leaders as they “ride the wave” of the technology innovation. However, the basic lines and rules of the competitive game remain drawn where they were.

Level 3 industry change – “Paradigm shift”

During a Level 3 change, the game changes, and as a result the old rules no longer apply. Not only have the goalposts been moved—they’ve been refashioned into nets. You find yourself suited up to play football, but the game is now soccer…or some new-to-the-world game, the rules to which are being written on the fly.

To complete the disk drive example, the current migration to cloud storage approaches a Level 3 change. With cloud computing, the end user no longer needs to buy hard drives and other storage media—he essentially rents storage over the Internet. That said, on the cloud you’re using someone else’s storage at a remote location, and that someone still needs physical storage media—so maybe this is more accurately not a full-blown 3, but let’s say a Level 2.5 change.

The regulation or deregulation of an industry typically creates a Level 3 change in that industry. This creates huge strategic challenges for existing players—including the most successful ones—and huge opportunities for new players better positioned to exploit the changed landscape.

For most of the 20th Century, the US telephone industry was dominated by a regulated monopoly affectionately known as ‘Ma Bell’ (AT&T). In 1984 it was broken up by an antitrust lawsuit, and forced to sell off its pieces (the “Baby Bells”, including what is now Verizon.) What was left of AT&T was significantly weakened, and was finally itself acquired by another of its spin-offs (SBC) to form what is now AT&T.

At the same time, the breakup unleashed a sustained wave of creative destruction from which, more than quarter-century later, we’re still reaping the benefits. Without it, the whole smart-phone industry, to name one, would not exist today as we know it.

Compound industry change

Where industry change becomes especially problematic is where you have two (or more) of these major changes occurring simultaneously or in rapid sequence. At The Knowledge Agency® we’ve been modeling the competitive dynamics in the US health insurance industry. The question we’re answering is, “How will competition change under health care reform?” Our conclusion is that health insurance is in the early stages of such a compound industry change.

Health care reform will likely lead to three concurrent Level 3 changes in the insurance industry. First, the industry, until now regulated primarily at the state level, will in addition—and possibly more aggressively—be regulated at the federal level. While it’s not a federal takeover of health insurance, the states are being told to respond to and work within what the federal law and regulations mandate.

It’s likely that this regulatory shift will accelerate a second major shift: the movement of the insurance industry from a series of local and regional markets to more of a unified national market (similar to what happened with US banks in the ’80s.) Already a wave of consolidations is under way.

Third, the primary health care reform law (Patient Protection and Affordable Care Act, Public Law 111-148) also mandates that following 2014 everyone be insured, and enables them to comply by requiring the states to offer online exchanges where insurance can be shopped and purchased. Many of us who are employed typically get health insurance through our employer, who usually also pays at least some of the cost. Those of us who are uninsured, whether through being unemployed or because our jobs don’t offer insurance, will as of 2014 be able to buy insurance directly.

For the industry, it means that where today they mainly sell to an employer’s management and human resources professionals (i.e., B-to-B), in the future they’ll also need to sell directly to the end consumer (i.e., B-to-C). Since consumers buy in fundamentally different ways than do businesses, this requires a major shift in how insurance products are designed, priced, marketed, and sold.

Thus the health insurance industry is facing a ‘triple-whammy’ industry change that compounds three extreme “Level 3” changes. This will create opportunity for new players, and will force existing players to competitively reinvent themselves under the new rules…

About this site

COMPETING IN THE KNOWLEDGE ECONOMY is written by Timothy Powell, an independent researcher and consultant in knowledge strategy. Tim is president of The Knowledge Agency® (TKA) and serves on the faculty of Columbia University's Information and Knowledge Strategy (IKNS) graduate program.

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"During my more than three decades in business, I've served more than 100 organizations, ranging from Fortune 500s to government agencies to start-ups. I document my observations here with the intention that they may help you achieve your goals, both professional and personal.

"These are my opinions, offered for your information only. They are not intended to substitute for professional advice."

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